Futures contract

standardized legal agreement to buy or sell something (usually a commodity or financial instrument) at a predetermined price (“forward price”) at a specified time (“delivery date”) in the future

A futures contract is an agreement between two parties.[1] The buyer pays the seller today for the promise of the commodity at a future date.[2] Futures contracts are traded in futures exchanges.[3] The commodities can be things such as livestock, agriculture produce, metals, energy, and financial products.[4] Trading futures can be profitable.[4] But it is also complex and very risky.[5] Instead of gaining a profit, an investor can lose the money invested.[4] They could be required to pay more than they invested.[5]

MarginEdit

Margin is the amount of money investors must give to the exchange, in order for contracts to be ensured against counterparty risk.[2] Initial margin ranges around 10% of the total value of the contract.[6] Margin rates can be lowered for hedgers since the contracts are covered by assets.

ExamplesEdit

  • Buffett is a farmer. He expects to harvest a hundredweight of corn. He wants a guaranteed price after the harvest is finished. Buffett would short a futures contract. He is obligated to deliver the corn at expiration.
  • Graham works for ABC Airlines. The company's performance is very sensitive to fuel prices, so ABC Airlines needs guaranteed fuel prices. Graham would buy a futures contract, and the airline would receive fuel at expiration, at the price set.
  • Hwang is a speculator. He believes that Treasury bond prices will go down. He shorts 10-year bond futures, and cancels his contract before expiration. If Hwang had incurred a large loss, his broker, or investment bank may have issued a margin call.

ReferencesEdit

  1. "Definition of 'Futures Contract'". The Economic Times. Bennett, Coleman & Co. Ltd. Retrieved December 9, 2016.
  2. 2.0 2.1 "What is a 'Futures Contract'". Investopedia. Retrieved December 9, 2016.
  3. "Futures Trading Basics". TheOptionsGuide.com. Retrieved 26 June 2015.
  4. 4.0 4.1 4.2 "Futures Contract". InvestingAnswers, Inc. Retrieved December 9, 2016.[permanent dead link]
  5. 5.0 5.1 "Futures Markets Basics". U.S. Commodies Futures Trading Commission. Retrieved 26 June 2015.
  6. "What Is Initial Margin?". Investopedia. Retrieved 2022-04-25.